REACTION PAPER

Decision making is an intricate process or method wherein we chose something

with our best interest among several alternatives. It will not contribute enough to be

fully understood and to effective decision making to be addressed only from the rational

point of view. Behavioral finance is an integral part of the decision-making process.

Individuals can improve their performance by recognizing the biases which was

discussed in the framework of behavioral finance. Understanding the possible negative

effects of biases allow individuals to make better choices in which then they can avoid

repeating the expensive errors in future.

On an article written by Baer et. al (2017) basing on previous McKinsey commentary

on the future of risk management in banking, highlighted six structural trends that are

expected to transform the risk function’s role in the coming decade. Of these, the trends

relating to regulation, costs, customer expectations, analytics, and digitization are

familiar, to one degree or another, to most readers. One trend that is less familiar

is debiasing, that is, using insights from the fields of psychology and behavioral

economics to help organizations take bias as much as possible out of risk decisions.

Biases are predispositions of a psychological, sociological, or even physiological nature

that can influence our decision making. They often operate subconsciously and by

definition are outside the logical process on which decisions are purportedly based.

While we may readily acknowledge their existence, we often believe that we ourselves

are not prone to bias. In fact, this is actually a form of bias in itself, called

overconfidence.
Moreover, cognitive bias is a systematic error in thinking that affects the decisions and

judgments that people make. Some of these biases are related to memory. The way

you remember an event may be biased for a number of reasons and that in turn can

lead to biased thinking and decision-making. Other cognitive biases might be related to

problems with attention. Since attention is a limited resource, people have to

be selective about what they pay attention to in the world around them. Because of this,

subtle biases can creep in and influence the way you see and think about the world.

To rectify cognitive bias is to further understand what it is. Imagine that you're

researching a potential product. You think that the market is growing, and, as part of

your research, you find information that supports this belief.

As a result, you decide that the product will do well, and you launch it, backed by a

major marketing campaign. However, the product fails. The market hasn't expanded, so

there are fewer customers than you expected. You can't sell enough of your products to

cover their costs, and you make a loss.

In this scenario, your decision was affected by confirmation bias. With this, you interpret

market information in a way that confirms your preconceptions instead of seeing it

objectively in which you make wrong decisions as a result.

Sometimes companies question least the decisions affecting their core business, such

as underwriting in banks and insurance companies. These decisions and their

governing processes can be so deeply embedded in the institutional culture that they

might not appear to be open to question or even recognized as decisions. The failure to
take debiasing actions in these areas means that most of the potential bottom-line

impact from debiasing remains unaddressed. Yet companies can shape practical,

targeted debiasing interventions and achieve tangible business benefits and with a

realization that debiasing techniques are substantial for companies’ success.

REFERENCES:

https://www.researchgate.net/publication/312600811_Behavioral_Biases_as_An_Effecti

ve_Factor_for_the_Firm_Financial_Decision-Making_A_Literature_Review

https://www.mckinsey.com/business-functions/risk/our-insights/the-business-logic-in-

debiasing

https://www.mindtools.com/pages/article/avoiding-psychological-bias.htm
 In Partial Fulfillment of

Behavioral Finance (FIN311) Requirements

Submitted by: Reuben Karlo L. Manayan

Submitted to: Prof. Romeo Pajigal

August 13, 2019